4tzs MAQecA445 COMMENT ON "How INDusTRmL~ REFORM WoRIKED IN CHINA: THE ROLE OF INNOVATION, COMPET1T1ON, AND PROPERTY RIGHTS," BY JEFFERSON AND RAWSIU Athar Hussain and Nicholas H. Stern T here are seven propositions in the artide by Jefferson and Rawski that embody the auhors' description of the process of industrial sector reform in China. Schematically, their contents may be presented as follows: f Greater efforts by frms Reform-s-- Compettion 4Reduced profits a-.- Further reforms i Lower government revenue The central driving force is intense competition between state-owned and town and village enterprises TVEs) which, by eroding the profits of state enterprises, spurs them to innovate or, in the authors' words, to climb the product ladder. Further, since profits constitute a key element of the tax base, reducing profits lowers tax rev- enue, thereby hardening the government budget constraint. The governrment responds by reducing subsidies to enterprises, forcing them to maintain the momen- tum of innovation. Then by draving lessons from the success of previous reforms, the government embarks on the next round of reform. The artide is silent about the fate of enterprises that are unable, or unwilling, to dimb. We argLue that such enter- prises are too numerous to be left out of the discussion. We agree with much of the argument of the article, but we have doubts about a number of key parts of the story and the treatment of data. First, we question the strength of empirical evidence provided in support of the analysis, particularly con- cerning profit and innovative activity. We also question some of the underlying descriptions of TVEs and state enterprises and the interactions between them and between firms and government. Finally, we consider the underlying causes of the rapid growth in China, pointing particularly to decentralization and incentives. Athar Hussain is director of the Development Economics Research Programme at the London School of Economics. Nicholas H7 Stern is chief economist at the European Bank for Reconstruction and Development. The authors thank Philippe Aghion for suggestions. Thesc comments draw on the research project on public finance in transition economics supportcd by the Economic and Social Research Council of the United Kingdom. Proceedings of the World Bank Amual Conference on Deveopment Economics 1994 01995 The Intcrnational Bank for Reconstruction and Dcvelopmcnt / THE WORLD mBNi 157 - r~. 158.. -, Comma on How Indusue Refom Workd in Chia Empirical Evidence We have reservations about taking the falling profit rate as an unambiguous index of competition. Measured profit rates have indeed fallen for all categories of enter- prises, but the counterpart has been a sharp rise in the share of value added going to labor. Such a shift seems to be central to the experience of other countries in tran- sition as well. Compared with market economies, the share of wages in value added tended to be low in command economies (Atkinson and Micklewright 1992). The decentralization of wage determnination and a relaxation in the rigor of state control seem to have increased the share of labor. Thus, at least part of the fall in prof- itability is due to rent-sharing rather than compcdtion. There is also a problem concerning how far the observed trend in profits reflects the actual trend. Compared with firms in a market economy, Chinese enterprises have both greater possibilities and greater incentives to underreport their profits. Independent accounting and auditing are still at a primitive stage, and the under- renorting of profits does not carry the same costs for Chinese enterprises as it does for firms in a market economy. For example, Chinese enterprises need not be greatly concerned with the implications of reported profits for stock market valuation or credit rating. Further, a part of the observed decline in profits may be due simply to the hiving off of more profitable activities (and the- associated resources) into sub- sidiary companies, which are private in practice but public in name. This process seems to be widespread and is described by the Chinese as "digging the socialist wall." The sbare of new products in total sales, which the authors use as the indicator of product innovation, raises two problems. First, a fal in total sales of old products will be reflected as a rise in product innovation even if such innovation is absent. One would also expect this fall in sales to be accompanied by a fail in profits. Thus the regression results showing a fall in profits apparently driving a rise in innovation may simply indicate a fall in total sales emanating from a fall in sales of old prod- ucts, which is raising the share of new products and depressing the profit rate. Second, the indicator is susceptible to serious measurement error in the Chinese context. Investment for the production of new goods is treated preferentially in the allocation of investment funds. This preference gives enterprises a strong incentive to repackage, or misrepresent, an old product as new. Alternative Perspectives on the Process The story in the article rests on competition between state enterprises and TVEs and innov2tion on the one hand and the ability or willingness of the government to sub- sidize loss-making enterprises on the other. While accepting much of what the authors have to say, we question key aspects of their analysis of both parts of the story. The pervasive government intervention in TVEs, which the authors mention, has implications for the interpretation of TVE entry and exit. The local governments that establish TVEs are fired by the goals of developing their area and of extending nonagricultural employment. The authors cite the higher frequency of closure for Hussein and Sum 159 TVEs than for state enterprises as evidence of competition and tighter budget con- straints. This link between closure and competition may well be part of the story, but the closures may also indicate that many TVEs are established without due regard for financial viability. Moreover, although the TVEs that are closed are loss- makers, many loss-making TVEs continue to operate. When assessing the role of competition in product markets we should remember that there may well be as many examples of TVEs operating in semiprotected local markets as there are of dynamic TVEs competing with state enterprises. Aside from trade barriers created by a strained transport system, examples of local protection abound; from time to time the central government has to remind local governments that levying duties and putting up barriers to the entry of goods produced in other areas is illegal. Sudi&es of TVEs suggest that they are highly heterogeneous and that their performance and behavior vary across regions (for example, Byrd and Lin 1990). The competitive role Jefferson and Rawski assign to TVEs does hold for a portion of such firms, but not alL State enterprises are similarly heterogenous. Some of them may innovate and cut costs, but there is no evidence that this is true for all or even most of them. The vir- tuous circle of competition and innovation sketched in the article is at odds with the mounting concern in China about the insolvency of a large percentage of state enterprises (and also TVEs). A recent System Reform Commission study of state enterprises in Liaoning (a leading industrial center) found that only 12 percent of 1,200 large and medium-size state enterprises in the province are on sound footing. Another 18 percent are operating well with respect to short-term criteria but still may not be able to survive without government assistance. The remaining 70 per- cent have major problems, and many of them are financially insolvent (Guo 1994). The Chinese economy has a huge number of nonviable enterprises; it has yet to devise an effective way of dealing with the problem. The regional diversity of China, which is crucial to understanding industrial reforms, does not play a central part in the argument of the article. State enterprises and TIVEs are unevenly distributed, and their performance varies widely across regions. The share of state enterprises showing losses is much higher in old, estab- lished industrial centers than in provinces with new enterprises (State Statistcal Bureau 1993). Dynamic TVEs- are often found in areas where state enterprises are thinly concentrated. Competition among enterprises, central to Jefferson's and Rawski's analysis, is often across government boundaries. Local governments have ways of stifling competition or cushioning its impact when their industrial base is threatened. They also differ widely in their attitudes toward industrial reforms. The description of the attitude of subnational governments provided by Jefferson and Rawski is not representative of the whole country. Thus the characterizations of competition from TVEs as universally intense and of the response of state enterprises as strongly innovative cannot be accepted with- out substantial qualification. The potential of further piecemeal reform for state enterprises and TVEs alike is now being questioned, and many in China are calling for drastic measures. 160 Commot on "How Indusmrwi Ribn Workedin CbnwC We also question the impression given in the article that subsidies to loss-maling firms are being rigorously controlled. Only direct subsidies are reported in table 5, and they constitute only the tip of the iceberg. Much larger are the indirect subsi- dies operating through loss-maling state trading agencies. These are essentially price subsidies. A substantial share goes to essential industrial inputs, such as steel and imported capital goods. In 1991, for example, direct subsidies to loss-making indus- trial enterprises accounted for 28 percent of the ttal budgetary outlay on subsidies, while budgetary subsidies to trading agencies accounted for 78 percent (Ministry of Finance 1992, p. 938). The authors mention soft loans from the banldng system but diminish their importance by categorizing them as "policy loans" destined for investment projects. An investment loan to a nonviable enterprise is still a subsidy. In addition, the web of interenterprise debt (the so-called triangular debt) ultimately has to be underwritten by the government Finally, a wide range of implicit subsidies are provided through the tax system. Enterprises may be allowed to offset loan prin- cipal repayments from their profits tax or even from indirect taxes, as in the elec- tricty industry. Circumstantial evidence does suggest that both the government (at all levels) and the banling system are taing a harder line on subsidies and loans to loss-making enterprises. Nevertheless, the budget constraints in China are still very soft by the standards of a market economy. Given the governments reluctance to permit bank- ruptcies, it does not have the option of calling a stop to subsidies to loss-making enterprises even when they are regarded as nonviable. The faill in fiscal revenue as a share of GNP is real and is cause for serious concern (Hussain and Stern 1992). However, we have to be careful in drawing the conclusion that the budget constraints are sufficiently hard to sustain the process of compettion and innovation outlined in the article. The financial capacity of the government to prop up loss-making enterprises, though it appears to have diminished in recent years, is far greater than indicated by its budgetary revenue. The boundaries of the govern- ment in a transition economy are far fom dear, and the financial constraint it faces cannot be simply deduced from its budget Nonbudgetary revenue in China has risen from 31 percent of budgetary revenue to 94.5 percent (Ministry of Fmance 1992, p. 924). This change is associated with, among other things, commercial pricing policies in public utilities and more entrepreneurial behavior in public institutions. Factors Other Than Competition in China's Reforms As economists, we are taught to extol the virtues of competition. But it seems to us that the authors exaggerate the role of competition in explaining recent phenomena in China, to the neglect of incentives and decentralization of decisionmaking in stimulating effort and enterprise. Surely what the Chinese have illustrated is some- thing obvious but fundamental: rewarding effort can elicit a substantial response even in the absence of radical institutional change. Decentralized governiment also has played a crucial role in the dynamics of China's reforms (Qian and Xu 1993). It has allowed local experimentation, letting some regions race ahead. The prolifera- Hussain and Stern 161 tion and explosive growth of TVEs owes a great deal to local initiative permitted by decentralization. But decentralization has also delayed reform of the tax system and impeded development of financial regulation and the conduct of macroeconomic policy. These are areas in which centralized decisionmaking has great advantages and can even be essential. The authors also underplay some other factors that are as important as competi- tion. For example, they attribute to the open door policy a rapid increase in imports of industrial goods, many of which they claim competed directly with domestic goods. In fact, much of China's imports have consisted of capital goods that Chinese industry is unable to produce, such as civilian aircraft, computers, and assembly lines. Imports that 'directly compete" wih domestically produced goods constitute only a small part of the total. A major contribution of the open door policy has been to upgrade the technology available to Chinese industry. Also, the fact that Chinese eco- nomic reforms brought an immediate tangible benefit to a large majority of the pop- ulation has played a central role in supporting the momentum of piecemeal reforms. Without the popular support that came with these benefits, the process would not easily have been sustained. Notwithstanding the political control of the Communist Party, the Chinese leadership is sensitive to the attitudes of the population. China and Other lTansition Economics The Chinese example refutes some of the more simplistic versions of the now fimil- iar argument that the best transition is always the fastest There are, however, important ways in which China's experience and circumstances differ from those in other transition economies. We highlight five. 1. China has been politically and economically stable. Notwithstanding changes in leadership since 1978, the basic approach to reforms has been remarkably consistent. 2. China's prereform economy differed from the command economies of the Soviet Union and Eastern Europe in some major respects. The economy was already highly decentralized in the sense that local governments had a great deal of discretion. This decentralization has made it possible to introduce piecemeal reforms and allow experimentation without disrupting the whole economy. Moreover, since much of industrial output was distributed outside the centralized supply system, the barriers to setting up new enterprises were comparatively low. Inputs for new activities could be obtained relatively easily. 3. An overwhelming percentage of the labor force was, and sdll is, located in rural areas and organized largely at the household leveL Market-oriented reforms are easier tO introduce in such an environment than in an economy dominated by large-scale industry and economic organizations. This rural-community- household structure means that market incentives can be introduced without building entirely new insttutions. Much activity can be generated merely by lifng the restraints on economic activities. The flexibility of the rural labor market has been crucial in facilitating the growth of TrVEs 162 Conmmeaon anmuw bzhsvd Reform Woredin ChhmG 4. China began its reform process with none of the major macroeconomic hand- icaps that afflicted many other postcommunist transition economies. The inflation rate was low, and government finances were in balance. China bad no international debt. Notwithstanding the acceleration in inflation since the mid-1980s, the savings propensity of Chinese households continues to be very high, making it much easier to sustain a high growth rate without run- away infladon. S. Hong Kong has played a crucial role in the rapid expansion of exports and the large inflow of foreign direct investment It has been the largest source of foreign capital, a major conduit for Chinese exports, and an invaluable source of commercial know-how for exporting to industrial market economies. In sum, these differences tell us that while China's example debunks some simple slogans masquerading as rigorous analysis, it does not necessarily provide a modd for all transition economies. Fmally, we would like to thank the authors for a stimulating article. It provides a challenging perspective on the Chinese experience and raises fruitful issues for dis- cussion and research. The artide is surely correct to focus on the relation between TVEs and stare enterprises and to emphasize that piecemeal reform can generate a momentum of its own. There is no doubt, to paraphrase Mao, that "lettng a hun- dred enterprises and activities bloom and contend" before destroying the old has served China welL References At.nson, A.B, and J. Mlddcwright. 1992. Economic Tlxmsbrmnion n EAstern Europe and the Distribu- Lion of Income. Cambridge: Cambridgr University Press. Byrd, William, and Lin Qinsong& 1990. China's Rul Industry: Stuctswr, Dewdopmen: and Reform. New York: Oxford University Press. Guo Shuqing. 1994. -Some Basic Issues tD Be Solved in Deepening Stare Enterprise Rrforms? System Reform Commission, Beijing. Hussain, Athar, and Nicholas Ster. 1992. 'Economic Reforms and Public Fniance in China? Public Firmanc (special issuc on Public Finance in a Word of Transition): 289-317. Ministry of Fiance. 1992. Zbcngo caibeng nianja 1992 (Puble Finsaxce Yearbook of China 1992). BeWiurg China Public Fnance Publishing House. Qian Ying, and Xu Chenggpng. 1993. "Why China's Economic Reforms Differ: The M-Form Hier- archy and Entty/Expansion of the Non-Sae Sector." Economics of Tansition 1(2): 13570. Stat Statistical Burcau. 1993. Industril Statisics Yearbook of China 1993. Beijng: China Statstical Publishing House. CoMMENT ON "How INDusTAL REFORM WoRKED IN CHINA: THE RoLE OF INNOVATION, COMPErTmION, AND PROPERTY RIGIHTS" BY JEFFERSON AND RAWSic Shahid Javed Burki M y view of industrial reform in China is conriderably different from the one offered by Gary Jefferson and Thomas Rawsli. Before presenting my view of the factors that contributed to the massive increase in industrial output and the dramatic restructuring of the industial sector in China, I want to provide some basic information about the performance of this sector. Transformation of China's Industry The Jefferson and Rawski artide offers a great deal of raw statistics to underscore the changes that have taken place in China's industry since the dawn of the reform era. Since the authors chose not to highlight some of the significant changes that have occurred, let me list jUSt a few: *B etween 1980 and 1992 the real output of industry in China increased nearly fivefold-n annual growth rate of 13.1 percent. * There was a striking change in the pattern of ownership of industrial assets during this period. In terms of output the share of the state-owned enter- prises declined from 76 percent to 48 percent, while that of the collectives increased from 24 percent to 30 percent. There was no privately owned industry in 1980; in 1992 private enterpises accounted for 7 percent of industrial output. * The losses of state-owned industrial enterprises increased sixfold in nominal terms fromYS billion in 1986 toY30 billion in 1991. The share of the state- owned industrial sector in total losses by state enterprises increased remark- ably, from one-ninth to one-third over this period. However, the coverage of these losses by government subsidies declined from 81 percent to 48 percent The distribution of subsidies to state-owned enterprises shows clearly that the government was not reluctant to expose industrial enterprises to compe- tition. It was more willing to protect nonindustrial state enterprises instead. * The return on capital invested in industry fell by more than half between 1980 and 1993-from 25.2 percent to 11.9 percent. Shahid Jawed Burki is vice prcsident, Latin America and Caribbcan Rcgional Office, at the World Bank. Proceedings of the World Bonk Annual Confrence on Development Economics 1994 01995 The Internationai Bank for Reconstrucion and Development / THE WORLD RINK 163 164 Conmnsmt on 7Hkw Indtrial ROM WO*ed in Chia" Jefferson and Rawski also provide information en wages for different classes of enterprises, changes in the profit-capital ratio, and levels of concentration in differ- ent industrial groups. This is a partial and somewhat idiosyncratic coverage of the data available on the Chinese industrial sector. To get a better picture of the characteristics of the indus- trial sector and its contribution to the development of the economy, it would have been helpful, for instance, to provide information on the geographic distribution of industrial output and on how it changed following the initiation of reforms. The authors also could have provided information on the geographical distribution of foreign direct investment, the contribution made by different industrial sectors to China's remarkable export performnance, or the increase in employment in different industrial categories. Had the authors cast their statistical net over a wider area, they might have reached a different conclusion about the factors that contributed to industrial performance in China. The Jefferson-Rawsli View of Industrial Transformation It is not always easy to understand the logic that supports the main conclusions Jefferson and Rawsld reach on the transformation of the Chinese industrial sector. I have also detected a number of contradictions between the seven propositions pre- sented in the second half of the artide and the principal argument laid out in the first half. However, I will not go into these problems. Instead I will focus on the larger pictre of China's industrialization. According to Jefferson and Rawski industrial reform in China was a consequence mostly of endogenous factors: the state gave the industrial sector a big push and then, essentially, sat back and watched internal factors take over and guide the sec- tor's evolution. We are told that enterprises and individuals by and large act on their own, proceeding on the basis of the impulses generated from within the industrial sector. The picture that is offered is that of a benign, laid-back state passively watch- ing-although not in a disinterested way-the evolution of the industrial sector. The disequilibrium that resulted from the actions initially taken by the state has kept the sector out of balance. Impulses move down the vertical ladder-from the state- owned industries at the top of the industrial apex to village enterprises at the bot- tom-and across dte horizontal structure as managers of enterprises at different layers of the system vigorously compete with one another. For some reason the authors label this process of change "gradualist," contrast- ing it with the top-down, exogenous, centrally planned reforms they believe were advocated by several international organizations for reforming the industrial sector of the former Soviet Union. Evolution of Chinese Industry: Another View I have a number of quarrels with both the hypothesis offered and the "gradualism" label applied to it. Since this is not the place to present my picture of China's indus- Burki 165 trial reform in detail, I concentrate on one important aspect that is central to the argument advanced by Jefferson and Rawski: the role of the state. I have a funda- mental difference with the authors. :n my view the state's role was much more con- tinuous and interventionist than the authors suggest. Consider the following six sets of policies adopted and vigorously pursued by the state that encouraged not only a sharp increase in industrial output but also the restructuring of the industrial sector. The first important decision, taken in the early 1980s, was to permit rural com- munities to keep the bulk of their incomes as savings and invest them in nonagri- cultural activities. Thus was born a new dass of entrepreneur operating in the countryside. This decision was the logical outcome of the enormous increase in rural incomes that, in turn, was a consequence of the disbanding of communes and the virtual privatization of agricultural assets. The state, by permitting the establishment of industries it could not control, was creating a new force whose full impact it did not then fully appreciate. The result was an enormous expansion in the number of town and village enterprises (1VEs) and a corresponding increase in their output. By the early 1990s the TVEs not only employed the same rnmber of workers as the state-owned sector but also had a considerably higher rate of job creadon. The expansion of the TVE sector, therefore, offered some welcome space within which the government could experiment with the restructuring of state-owned industrial enterprises. Second, having made the decision that led not only to the remarkable growth of the industrial sector but also to its dramatic restructuring, the government, by changing relative prices, altered the environment in which state-owned enterprises had functioned since their founding. The changes in relative prices came gradually, and after a great deal of deliberation and experimentation. By the early 1990s most of the decisions taken at the margin by industrial managers-in both the state and the nonstate sectors-were based on market signals Third, Chinese policymakers granted considerable economic autonomy to provincial and municipal governments. The coastal provinces and several large coastal cities were given an extraordinary amount of authority to conduct their eco- nomic affairs. But for that, the coastal provinces would not have grown at the rate they did, Chinese exports would not have increased at the rate they did, and joint ventures would not have become one of the most dynamic elements in the Chinese industrial sector. Fourth, by about the middle of the 1980s the state began to experiment with the restructuring of the industrial enterprises it owned. This experimentation continues today. No satisfactory formula has been found for improving the efficiency of state- owned enterprises, but the state is willing to take time to find the right set of solutions. Fifth, the slow and deliberate pace of reform of state-owned enterprises is moti- vated by the leadership's strong desire to maintain social stability. The leadership is unwilling to risk social instability in order to improve enterprise efficiency. It is pro- ceeding on three tracks simultaneouslry creating new institutions that will ultimately assume responsibility from state enterprises for providing housing and social secu- rity, allowing the nonstate sector to expand rapidly to permit the transfer of work- 166 Comment on 'How Industil Reform Worked i China ers from the state to the nonstate sector, and continuing in the interim with various experiments to restructure the enterprises. Sixth, lacking instruments of macroeconomic control for dealing with the fre- quent boom and bust cycles, the state has applied all manner of administrative and political devices to restore equilibrium in the financial, labor, and product markets and to curb investments in overheated sectors that were attracting speculative capi- tal. The state has also been prepared to use the large external balances it has at its disposal to cool the economy with more imports. Conclusion I could go on listing govemment policies in order to underscore my point: the state in China has been active and interventionist in its approach toward economic reforms, particularly in the industrial sector. It has also been gradualist, but not in the sense implied by Jefferson and Rawski. It moved slowly and continuously after a great deal of experimentation. Its primary concern remains the rapid development of industry that will allow it to restructure state-owned enterprises and accommo- date the large number of workers-perhaps as many as 20 to 30 million-that would inevitably be displaced. This, I believe, is a more accurate picture of the trans- formation of the industrial sector than the one offered by the authors. FLOOR DISCUSSION OF "How INDUSTRiAL REFORM WORKED IN CHINA: THE ROLE OF INNOVATION, COMPEITION, AND PROPERTY RIGHTS," BY JEFFERSON AND RAWSKI R awski saw no great disagreement between his and Jefferson's analysis and the discussants' comments; rather, it seemed to him, they were interpreting the same thing in different ways. This was both encouraging, responded Shahid Burki (discussant), and a typical Chinese response to external criticism: to make it endogenous. A participant asked what role ideas-and ideologies-played in industrial reform in China. Ideas that existed long before 1978, replied Rawski, were important in China's reform; indeed, as far back as 1956 proposals for the second five-year plan involved small-scale industry, decentralized local control, and other elements that surfaced in the reform effort twenty years later. One of the refreshing things about China, added Nicholas Stern (discussant), is that it is one of the most unideological countries imaginable. Pragmatism is much more of a driving force. Rawski said that he could not agree more with Stem, for example, about the incentive to conceal profits in Chinese industry; he was amazed whenever someone said two-thirds or more of state enterprises lost money, because those loss figua es were fiscal data. So he agreed that there was a data problem, but how, then, did Stem explain convergence phenomena? Stern rephrased the question before responding: why, if the older numbers were made up, would they all converge? He would emphasize another aspect of the data in trying to understand why profits had fallen. In his view, profits had dropped because the labor force had negotiated a larger share of them in response to the firms' greater discretion in the disposal of value added. Then the question is, how far can profits decline? In Stem's view the only constraint on how far you can reduce reported profits is what you can negotiate with local tax authorities. He prefers that interpretation rather than one involving a highly mobile and competi- tive capital market, which he thinks does not yet exist in China. He would not insist on any interpretation, but he would rather focus on constraints on labor's share than on profits in a mobile capital market. To turn the question of what happened to profits around and ask what happened to labor's share is simply a different way of looking at the same phenomenon. If the profit rate goes down, labor's share goes This session was chaired by Robert Piccioeto, director-eneral, Operations Evaluation, at the World Bank. Proceedings of the World Bank Annual Conferece an Devdopment Econonics 1994 01995 The Ihtenational Bank for Reconstruction and Development / THE WORLD IANK 167 168 Floor Discussion of -How Indusridal Refonn Wored in China" up. But to focus on labor's share does raise different questions, such as how labor's share is determined and what discretion there is. These issues are part of any story about competition and may in fact be more important. Responding to the repeated mention of labor's increasing share of inconmc in state enterprises, Jefferson observed that labor's share of income had risen from close to 7 percent in 1980 to just under 8 percent in 1990, which as a share of gross output is not that large an increase. A substantial share of compensation for state enterprise workers came from in-kind payments (in the form of housing, health care, school- ing, and other social services), but these were unlikely to have represented more than S or 6 percent of gross output. Labor's output dasticity in state industry is at least 15 percent, he continued, which suggests that its contribution to industrial out- put is about 15 percent of total inputs. We would not reject the hypothesis that labor's share of income is consistent with its technical contribution to production, said Jefferson. We're not referring only to the profit data in the article, rejoined Rawski. Many results based on econometric analyses of sample data from Chinese enterprises- some by jefferson and Rawski, some by others-are converging on relationships that one would expect to see in a competitive market. If the data are hokey, Rawski asked, where do these results come from? If the role of the state was so important, Rawski asked Burki, then who pushed the suicide lever that drove the ratio of government revenue to GNP from 35 per- cent to 14 percent in thirteen to fifteen years? Of course, Rawski acknowledged, the government was active and there were exogenous factors at work; Hong Kong and the open door policy were also important. He and Jefferson were not claiming that everything was endogenous. But despite the strictures of the discussants, Rawski believed an important endogenous process was going on, that competition was important, and that the government was reacting as often as it was leading. To understand how the Chinese industrial sector has functioned, responded Burki, you have to take a more balanced view. You cannot just factor out the role of the state. And explaining the rapid decline of the state's share in revenues does not demonstrate the correctness of one hypothesis or another. These are outcomes of how the state was proceeding: it would go forward a couple of steps and then retreat one step. The state was at that very moment trying to respond to the problem Rawski had suggested, which is that both enterprises and provinces have benefited gready from the autonomy the state had allowed them. That is at the crux of the Chinese experience with reform. Rawski asked Burki if he knew of Pny document published in China in the early or mid-1980s suggesting that policymakers knew that reform would bring about a big decline in government revenues and yet decided to go forward with it anyway. There would be no such document because this was an unexpected outcome for pol- icymakers, which is why he and Jefferson leaned toward the interpretation that the government, although active and purposeful, was not in charge and was reacting as much as it was acting. Burki was sure Rawski was not surprised that studies of this kind did not eisL Part of the beauty of the Chinese experience, Burki said, was that Floor Disussion of -How Industnal Reform Worked in China" 169 China was not only so unideological but also so unplanned. The Chinese take posi- tions without reflecting too much on the long-term consequences, which is why there is constant experimentation, study, adjustment, and so forth. There is very lit- tle ex ante work and a great deal of ex post work. Jefferson said that there may be room for argument on both sides in the debate about a balanced or unbalanced approach to growth. On one side of the debate Rosenstein-Rodan and Nurkse advocated a balanced growth approach to develop- ment, and on the other side Hirschman advocated an unbalanced growth approach. Jefferson suspected that in hindsight each might appreciate the other's point of view. Hirschman, besides emphasizing links within the economic-especially the indus- trial-system, might also acknowledge the importance of coordinated investnents by the state. And those on the other side of the debate might appreciate the sponta- neous links that exist within the industrial system. Asked to comment, Burki said that China is so complex and unique that it would not further understanding to force China's experience into any particular bottle. He would prefer to reflect on what had happened and try to explain it without bringing in various theories on other situations. A participant from the University of Massachusetts asked for observations about the training or retraining of China's managerial cadre. Was that approach to train- ing transferable to Eastern Europe? Rawski said that he did not know enough about the training of managers in the 1990s to answer the question usefully. The partici- pant observed that, if managers in China are responding to competitive pressure, surely not all managers art ..sponding equally rapidly or well. Has any work been done to identify the factors that explain differences in managerse ability to respond? Rawsld responded that not much is known about managerial labor markets in China and the factors t&at ;eterrnine managerial performance. A participant from the University of Pennsylvania asked for comments on the tremendous investment, technical assistce, and know-how the overseas Chinese had brought to China. Jefferson agreed that their contribution had been very impor- tant. The Chinese statistical yearbook, he said, shows an average of 100,000 border crossings a day between China and Guandung Province, and he suspected that most people crossing the border were carrying export orders, technologies, managerial resources, and other factors important to industrial development This was consis- tent, he said, with their emphasis on the spontaneous bottom-up nature of reform, even when initiated by the center. Observing that China's population is far more rural than that of Eastern Europe, a participant from the London School of Economics asked how important that is in terms of providing a spare labor force for industrial activity that was unavailable in Eastem Europe (Eastern Europe's main labor force being trapped in state enter- prises). How do they face that problem? Rawski replied that the nonagricultural labor force's low share in China's economy gives China added flexibility, but that a real problem r mains: steel enterprises, for example, that need only 50,000 work- ers employ 150,000. People are being guaranteed pensions when pension funds have not accumulated, people are living in houses that cannot be profitably maintained, 170 Floor Discwian of -Iow Idusial Re/bm Wbokedin Chib and these problems will not go away. Despite a big agricultural sector, China's huge state industrial sector employs 40 million workers, and the problems of reform are immense, painfil, and intractable. Jefferson added that extending the notion of Grossman and Helpman's quality ladder into China's domestic industry was not a mere abstraction; it was based on observation. He and Rawski had recently visited a township and village enterprise (IVE), a garment factory outside Beijing, in which the factory manager told them that she was competing both with state enterprises, which produced higher-quality garments (but at a higher cost), and with households, which produced lower-qual- ity products (but at a lower cost). This suggested to Jefferson and Rawski that prod- uct quality and innovations were moving down the ladder and that competition was moving up. Certainly the factory director was aware of the situation. Burki said that he would place the ladder between Guandung and the rest of the country, because innovation was coming from Guandung and was not restricted to state enterprises. On the contrary, provincial and joint enterprises (in which the state enterprises were not active) had become leaders in innovation and technology. One participant asked how, in hypothesis testing, the effects of overall changes on a sector or industry were isolated from the effects of TVEs on state enterprses. Jefferson suggested looking at the paper by Inderjit Singh, Dilip Ratha, and Geng Xiao (cited in the Jefferson-Rawski article), who, using provincial panel data, found that the larger was the nonstate share of industial output, the lower was the prof- itability-or, the more the nonstate sector grew, the faster profitability fell. They also found that the more the nonstate sector grew, the fIaster total factor productmty rose. In fact, said Jefferson, state-owned enterprises are responding to competition. Certainly, many of them are not responding to competition-and they are being left behind. Derek Morris, using another data set, suggests a dose relationship between investment and gross profitability, and it does seem that the enterprises that are per- forming well are those that can capture investment resources and expand produc- ton. Those that do not capture resources and cannot expand capacity are not performing well and are falling behind. A participant from the Congressional Search Division of the Library of Congress observed that with China midstream in the reform process, there was dearly a prob- lem with the distribution of wealth-a cleavage between urban and rural centers and between coastal areas and the hinterlands. So where does the system go? Some eco- nomnic problems, especially between peasants and factory workers, could become political problems, especially in areas where politics are hanging by a thread. Income distribution is an important issue in any large country, responded Rawsli. At the beginning of the People's Republic, in the early 1950s, there were huge gaps in income distribution between urban and rural citizens and within the rural sector. Chinese policies cut off the tails of the income distribution, but large inequalities remained when reform began. Reform has lessened some inequalities and magnified others. Will distribution be an issue in the future? Of course. But is Chinese politics hanging by a thread? Rawski didn't think so, although he hesitated to comment on such matters.